CLEANLINESS IS NEXT TO GODLINESS
Duration: 150 mins
Slides: 14
LM THAPAR SCHOOL OF MANAGEMENT,
THAPAR INSTITUTE OF ENGINEERING & TECHNOLOGY
Masters of Business Administration
Course: Management Accounting
Faculty: Dr. Sonia Garg (Email: sonia.garg@thapar.edu)
Session 14-15: Marginal and Absorption Costing
Session Learning Objectives
• Identify what distinguishes marginal costing from
absorption costing
• Compute income under marginal and absorption
costing and explain the difference
• Differentiate throughput costing from marginal and
absorption costing
• Compute breakeven points for marginal and absorption
costing
Marginal and Absorption Costing
Marginal costing v/s Absorption
costing
•
Marginal costing is a method of inventory costing in which only variable
manufacturing costs are included as inventoriable costs
•
Absorption costing is a method of inventory costing in which all variable
manufacturing costs and all fixed manufacturing costs are included as
inventoriable costs
•
Operating Income will differ between Absorption and Marginal Costing
•
The amount of the difference represents the amount of Fixed Product
Costs capitalized as Inventory under Absorption costing, and expensed as
a period costs under Marginal Costing
Marginal and Absorption Costing
Example
April
May
Beginning Inventory
0
150
Production
500
400
Sales
350
520
Manufacturing costs per unit produced
Rs. 1,00,000
Rs. 1,00,000
Operating costs per unit sold
Rs. 30,000
Rs. 30,000
Variable Costs
Fixed Costs
Manufacturing costs
Rs. 2,00,00,000 Rs. 2,00,00,000
Operating costs
Rs. 60,00,000
The selling price is Rs. 2,40,000
Marginal and Absorption Costing
Rs. 60,00,000
April
May
Beginning Inventory
0
150
Solution
Production
500
400
Goods available for
sale
500
550
Marginal Costing
Units sold
350
520
Ending inventory
150
30
Revenue
April
May
2,40,000*350 = 8,40,00,000
2,40,000*520 = 12,48,00,000
0
1,00,000*150 = 1,50,00,000
1,00,000*500 = 5,00,00,000
1,00,000*400 = 4,00,00,000
5,00,00,000
5,50,00,000
(1,00,000*150 = 1,50,00,000)
(1,00,000*30 = 30,00,000)
3,50,00,000
5,20,00,000
30,000*350 = 1,05,00,000
30,000*520 = 1,56,00,000
2,00,00,000
2,00,00,000
60,00,000
60,00,000
Costs:
Beginning Inventory
Variable manufacturing costs
Variable cost of goods available
for sale
Deduct Ending Inventory
Variable COGS
Variable operating costs
Fixed Manufacturing costs
Fixed operating costs
Operating Income
Marginal and Absorption Costing
1,25,00,000
3,12,00,000
Absorption costing
April
May
Fixed manufacturing costs
2,00,00,000
2,00,00,00
0
Units produced
500
400
Fixed manufacturing cost per unit
40,000
50,000
Variable manufacturing cost per unit
1,00,000
1,00,000
Total manufacturing cost per unit
1,40,000
1,50,000
April
May
2,40,000*350 = 8,40,00,000
2,40,000*520 = 12,48,00,000
0
2,10,00,000
1,00,000*500 = 5,00,00,000
1,00,000*400 = 4,00,00,000
Fixed Manufacturing costs
2,00,00,000
2,00,00,000
Cost of goods available for sale
7,00,00,000
8,10,00,000
(1,40,000*150 = 2,10,00,000)
(1,50,000*30= 45,00,000)
4,90,00,000
7,65,00,000
30,000*350 = 1,05,00,000
30,000*520 = 1,56,00,000
60,00,000
60,00,000
1,85,00,000
2,67,00,000
Revenue
Costs:
Beginning Inventory
Variable manufacturing costs
Deduct Ending Inventory
COGS
Variable operating costs
Fixed operating costs
Operating Income
Marginal and Absorption Costing
Operating income difference
• Absorption costing operating income – Marginal
costing operating income = fixed manufacturing costs
in ending inventory – fixed manufacturing costs in
beginning inventory
• April:
 1,85,00,000 – 1,25,00,000 = (40,000*150)-0
 60,00,000 = 60,00,000
• May:
 2,67,00,000 – 3,12,00,000 = (50,000*30) – (40,000*150)
 -45,00,000 = -45,00,000
Marginal and Absorption Costing
How do changes in unit inventory cost
affect operating income
Marginal Costing
Absorption Costing
Production = Sales
Equal
Equal
Production > Sales
Lower
Higher
Production < Sales
Higher
Lower
Marginal and Absorption Costing
Performance Issues and Absorption Costing
•
Managers may seek to manipulate income by producing too many units
•
Production beyond demand will increase the amount of inventory on hand
•
This will result in more fixed costs being capitalized as inventory
•
That will leave a smaller amount of fixed costs to be expensed during the
period
•
Profit increases, and potentially so does a manger’s bonus
•
REMEDY: base manager’s bonuses on profit calculated using Marginal Costing
Marginal and Absorption Costing
Other Issues
•
Deciding to manufacture products that absorb the highest amount of fixed
costs, regardless of demand (“cherry-picking”)
•
Accepting an order to increase production, even though another plant in
the same firm is better suited to handle that order
•
Deferring maintenance
•
REMEDIES
o Careful budgeting and inventory planning
o Incorporate an internal carrying charge for inventory
o Change (lengthen) the period used to evaluate performance
o Include nonfinancial as well as financial variables in the measures to evaluate
performance
Marginal and Absorption Costing
Extreme Variable Costing: Throughput
Costing
• Throughput costing (super-variable costing) is a method of
inventory costing in which only direct material costs are
included as inventory costs.
• All other product costs are treated as operating expenses
Marginal and Absorption Costing
Break even point
For Marginal costing: Break even point is unique
– Break even point (in units) = total fixed cost/contribution margin per
unit
– No. of units sold = (total fixed cost + target operating
income)/contribution margin per unit
For Absorption costing: Break even point is not unique
– No. of units sold =(total fixed cost + target operating income+ [fixed
manufacturing cost rate*(breakeven sales in units – units
produced)])/contribution margin per unit
– The term fixed manufacturing cost rate*(breakeven sales in units –
units produced) reduces the fixed costs that need to be recovered
when units produced are more than breakeven sales quantity
Marginal and Absorption Costing
Questions
Alvin Inc. planned and actually manufactured 200,000 units of its single product in
2008, its first year of operations. Variable manufacturing costs were $30 per unit of
product. Planned and actual fixed manufacturing costs were $600,000, and marketing
and administrative costs totaled $400,000 in 2008. Alvin sold 120,000 units of product
in 2008 at a selling price of $40 per unit.
Alvin’s 2008 operating income using marginal costing is
a. $800,000.
b. $600,000.
c. $440,000.
d. $200,000.
Alvin’s 2008 operating income using absorption costing is
a. $840,000.
b. $800,000.
c. $440,000.
d. $200,000.
Marginal and Absorption Costing
Operating income using marginal costing as compared to absorption costing would be higher
a)
b)
c)
d)
when the quantity of beginning inventory equals the quantity of ending inventory.
when the quantity of beginning inventory is more than the quantity of ending inventory.
when the quantity of beginning inventory is less than the quantity of ending inventory.
under no circumstances.
Absorption costing enables managers to increase operating income in the short run by changing
production schedules. Which statement is true regarding such action?
a)
b)
c)
d)
The reason for increased operating income is the deferral of fixed manufacturing overhead
contained in unsold inventory.
A desirable effect of these changes in production is “cherry picking” the production line.
This is done through decreases in the production schedule as customer demand for
product falls.
None of the above statements are true regarding the manager’s action to increase
operating income through changes in the production schedule.
The proponents of throughput costing
a)
maintain that variable costing undervalues inventories.
b)
maintain that it provides more incentive to produce for inventory than do either variable or
absorption costing.
c)
argue that only direct materials and direct labor are “truly variable” and all indirect
manufacturing costs be written off in the period in which they are incurred.
d)
treat all costs except those related to variable direct materials as costs of the period in
which they are incurred.
Marginal and Absorption Costing